Fitch Upgrades East Kentucky Power Co-op Bonds to 'A-'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has upgraded the underlying rating on East Kentucky Power Cooperative's (EKPC or the cooperative) $5,000,000 Pulaski County, KY solid waste disposal revenue bonds series 1993B to 'A-' from 'BBB+'.

In addition, Fitch has upgraded EKPC's implied senior unsecured obligations to 'A-' from 'BBB+'. The rating takes into account $47.8 million of unsecured debt at Dec. 31, 2015, but is assigned to implied obligations, since none of the outstanding unsecured debt is publicly held.

The Rating Outlook has been revised to Stable from Positive.

KEY RATING DRIVERS

SUSTAINED FINANCIAL PERFORMANCE: The rating upgrade reflects EKPC's sustained financial performance and an expectation that the cooperative will maintain financial metrics supportive of the 'A-' rating category. EKPC's financial profile has improved considerably in recent years, reflecting the execution of its comprehensive strategic plan and solid regulatory support. EKPC achieved its goal of a minimum equity ratio of 15% in FYE 2015 and debt service coverage (DSC) of 1.25x-1.35x in the past three fiscals years.

GENERATION AND TRANSMISSION COOPERATIVE: EKPC is a generation and transmission (G&T) cooperative that supplies power to 16 member-owner distribution systems, who serve predominantly rural territories in 87 counties in central and eastern Kentucky. Wholesale power agreements extend through Jan. 1, 2051, and require members to serve their entire load through purchases from EKPC, with a minor exception.

INCREASINGLY DIVERSIFIED POWER SUPPLY: EKPC completed the purchase of a 567 MW natural gas-fired facility from Bluegrass Generation Co. LLC (Bluegrass) in December 2015. The new plant effectively replaces the 200MW Dale Station coal power plant, which was retired in April 2016, and reduces EKPC's reliance on coal-fired units. Power supply should be sufficient to meet members' peak energy demands for the next decade.

RATE REGULATED: Wholesale electric rates and those of its members are regulated by the Kentucky Public Service Commission (PSC). The PSC has a history of being supportive of EKPC, but regulatory oversight creates a level of risk.

ADEQUATE LIQUIDITY: Cash levels have rebounded in 2016, as expected, following the purchase of the natural gas-fired facility from Bluegrass in December 2015. Cash on hand as of August 31, 2016 was roughly in line with the utility's target of 100 days. Robust liquidity should help buffer the effects of rate regulation on EKPC.

RATING SENSITIVITIES

MATERIAL INCREASE IN LEVERAGE: Given already high leverage, a significant increase in East Kentucky Power Cooperative's (EKPC) debt related to future environmental compliance costs or other resource decisions could lead to a rating downgrade.

SHIFT IN REGULATORY POLICY: Evidence of a less supportive shift in public service commission regulatory policy, that negatively affects EKPC's financial results, would be viewed negatively.

CREDIT PROFILE

AMPLE AND INCREASINGLY DIVERSIFIED POWER SUPPLY

EKPC boasts a diverse generating fleet of coal-fired, natural gas-fired and landfill gas power plants totaling more than 3,400 MWs. Favorably, EKPC has taken steps to reduce its reliance on coal-fired generation and keep production costs low through optimization of its asset portfolio and flexible generation dispatching.

The cooperative purchased a 567 MW natural gas-fired facility in December 2015 and subsequently retired the Dale Station facility, a 200 MW coal power plant, in April 2016. Coal now represents only half of EKPC's owned power supply, down from two-thirds at FYE 2014. As natural gas prices have declined, EKPC has been able to utilize its gas-fired generation along with wholesale market purchases to hold down costs.

ENVIRONMENTAL COMPLIANCE COSTS

Management believes that it is well positioned to meet the increasingly stringent emissions requirements proposed by the Environmental Protection Agency (EPA). Substantial, but manageable, expenditures for environmental modifications at EKPC's coal-fired Spurlock plant are planned in the 2019 - 2024 timeframe. EKPC also expects to complete the removal of coal ash from the Dale Station in the summer of 2017. Total capital spending is estimated at approximately $105 million per annum through 2020.

EKPC's forecasts exclude any necessary Clean Power Plan investments, as compliance strategies continue to evolve.

SOUND FINANCIAL PERFORMANCE

EKPC continued its stable financial performance in FY 2015 despite confronting less favorable weather and market conditions. A decrease in operating revenue to $885.1 million in FY 2015 from $952.8 million in FY 2014 was mitigated by a $52.5 million decrease in operating expenses, primarily as a result of lower fuel prices and lower load requirements. Fitch calculated DSC for FY 2015 was 1.27x, down marginally from 1.31x in 2014.

Total debt has continued to decline in recent years, but leverage in terms of debt to funds available for debt service remains above 9.0x.

Although cash balances declined, EKPC's liquidity remained strong with 318 days liquidity on hand at FYE 2015, above 'A' rating category medians. The cooperative had maintained meaningful availability under its $500 million syndicated credit facility with only $35 million drawn at FYE 2015. The facility, which has since been increased to $600 million, will provide a source of liquidity for potential costs resulting from Clean Power Plan.

Preliminary 2016 financial results through Aug. 31, 2016 suggest strengthened financial performance. Cash increased to $155M, or 112 DCOH, bringing liquidity more in line with historical levels following purchase of the natural gas-fired facility in December 2015. DSC also increased to 1.37x and EKPC maintained an equity to asset ratio above 15%.

EKPC's long-term financial forecast assumes healthy annual net margins, which are sufficient to provide annual DSC of approximately 1.29x-1.38x and a times interest earning ratio (TIER) above 1.39x. Equity as a percentage of capitalization is expected to continue to increase, rising to 25% by 2021 before any capital credit payments.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Public Power Rating Criteria (pub. 18 May 2015)

https://www.fitchratings.com/site/re/864007

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013346

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013346

Endorsement Policy

https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
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Associate Director
+1-512-813-5702
Fitch Ratings, Inc.
111 Congress Ave, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
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+1-512-215-3730
or
Media Relations:
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Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Tim Morilla
Associate Director
+1-512-813-5702
Fitch Ratings, Inc.
111 Congress Ave, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Kathy Masterson
Senior Director
+1-512-215-3730
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com